Paul Krugman and Poor France

by Veronique de Rugy

New York Times columnist Paul Krugman is outraged by Standard & Poor’s decision last week to downgrade France to a AA+ bond rating. Without defending S&P in general or in this particular case, I’d note that Krugman’s article is surprising in several ways. First, according to him, the downgrade has nothing to do with the country’s economic health, because France is doing relatively well compared with other countries, and the U.K. in particular (he claims). Instead, this plot against France is both the product of  people’s disdain for the poor and S&P’s misguided condemnation of France’s attempt to reduce its deficit by raising taxes. He writes:

By the numbers, then, it’s hard to see why France deserves any particular opprobrium. So again, what’s going on?

Here’s a clue: Two months ago Olli Rehn, Europe’s commissioner for economic and monetary affairs — and one of the prime movers behind harsh austerity policies — dismissed France’s seemingly exemplary fiscal policy. Why? Because it was based on tax increases rather than spending cuts — and tax hikes, he declared, would “destroy growth and handicap the creation of jobs.”

In other words, never mind what I said about fiscal discipline, you’re supposed to be dismantling the safety net.

S.& P.’s explanation of its downgrade, though less clearly stated, amounted to the same thing: France was being downgraded because “the French government’s current approach to budgetary and structural reforms to taxation, as well as to product, services and labor markets, is unlikely to substantially raise France’s medium-term growth prospects.” Again, never mind the budget numbers, where are the tax cuts and deregulation?

See what happened? If you’re calling for spending reductions and saying that tax increases will hurt the economy, it means you want to dismantle the safety net — not reduce or reform, just take it apart entirely. He continues:

You might think that Mr. Rehn and S.& P. were basing their demands on solid evidence that spending cuts are in fact better for the economy than tax increases. But they weren’t. In fact, research at the I.M.F. suggests that when you’re trying to reduce deficits in a recession, the opposite is true: temporary tax hikes do much less damage than spending cuts.

Really? It’s a lot more complicated than what Kugman wants you to believe. The literature (including the IMF literature!) does show that, while spending cuts will effectively reduce a country’s debt and spending-based fiscal adjustments are beneficial to growth in the long term, they do not necessarily grow the economy in the short term. Bur Krugman is simply wrong that spending cuts are clearly more damaging than tax increases. One leading paper in the austerity debate, usually cited to show that spending cuts don’t grow the economy, is by IMF economists Jaime Guajardo, Daniel Leigh, and Andrea Pescatori. But the paper also shows that, while spending cuts can hurt the economy in the short run, they probably don’t hurt the economy as much as tax increases. In fact, during a recent talk at the Heritage Foundation on the issue of fiscal adjustments, Daniel Leigh showed that spending cuts could be just one-third as painful as tax increases. There are always caveats to such findings, and Leigh was careful to pointing them out, but that should at least raise some suspicious about Krugman’s bold statement.

There’s plenty more evidence that tax increases are hurtful to the economy: Obviously, the work of economist Alberto Alesina (a leading force in the research on fiscal adjustments) has provided lots of evidence that, historically, tax-based adjustments were not effective at reducing the debt-to-GDP ratio and were also very bad for the economy. But there is more: The new work of Heritage Foundation’s Salim Furth  looks at the data from the most recent episodes of fiscal adjustment, mostly in the U.S. and in Europe. He too finds very compelling evidence that raising taxes isn’t the way to go (unless you are trying to tank your economy).

Finally, I suspect that French people would be surprised to hear that France is doing well, or that it is doing better than the U.K.  For one thing, unemployment in the U.K is roughly 7.7 percent, while in France the rate is almost 11 percent (and likely to continue growing). French people are leaving the country to escape high taxes, young people are leaving to try to get jobs (mostly in London), there are riots in the streets of Brittany, and people are generally feeling that things have gone terribly wrong. Reuters has some numbers:

The French economy contracted by 0.1 percent, snuffing out signs of revival in the previous three months. It had been expected to post quarterly growth of 0.1 percent and has now shrunk in three of the last four quarters.

German growth slowed to 0.3 percent, from a robust 0.7 in the second quarter, but Europe’s largest economy clearly remains in much better shape.

France is becoming a focus for concern within the currency bloc. The Bank of France predicts the economy will expand by 0.4 percent in the last quarter of the year but the government’s labor and pension reforms are widely viewed as too timid.

A report on French competitiveness by the Paris-based Organization for Economic Cooperation and Development warned that it is falling behind southern European countries that have cut labor costs and become leaner and meaner.

This article, in French, has a series of good charts contrasting the U.K and France and fact-checking Krugman’s claims.